Is Your Fund Pawning Shares at Your Expense?

WSJ's Zweig posted this story:
Is Your Fund Pawning Shares at Your Expense?


cute analogy
"Imagine you hire a real-estate agent to sublet your house. Now imagine he keeps 30% to 50% of the rent for himself. Finally, imagine that the real-estate agent makes you pay for the damages that resulted when the tenants he brought in trashed your house."

terrible conclusion:

"Your fund should lend out your securities, but the proceeds should go to you. And fund managers should reinvest the collateral only in absolutely safe securities. The current system, where they keep half the gains and stick you with all the risks, has got to go."

Why is he in favor of lending at all? His analogy was creative... but didn't go far enough. 

In his view the "trashing of the house" was representative of not the short sellers tanking your stock  but when the agent firm who lent out your stock and managed the fees collected gets in trouble.

so just to clarify the analogy based on his examples below the quote:

the real estate agent = investment banker

lends house out = lending shares to short sellers

rent is fee collected from short sellers but agent keeps 30-50% of the rent

[Assume typical housing managers collect 10-15% + bonus for finding tenant?]

pay for the damages that resulted when the tenants he brought in trashed your house = the fees were put in an unsafe investment and the fund holder had to pay for the damages instead of the agent???

 Um no that doesn't work right as a comparison.... 

Given his conclusions and examples he should have said:

"Imagine you hire a real-estate agent to sublet your house. Now imagine he keeps 30% to 50% of the rent for himself. Finally, imagine that the real-estate agent makes you pay for the damages when you gave him the  fees to "manage" and lost the fees investing in beanie babies."

however I think he really had it right the first time but misdirected us away from the real problem

lets review

"Imagine you hire a real-estate agent to sublet your house. Now imagine he keeps 30% to 50% of the rent for himself. Finally, imagine that the real-estate agent makes you pay for the damages that resulted when the tenants he brought in trashed your house."

Mr. Zweig, you had it right THE paramount fear of a homeowner is the fact your real estate agent willfully rented out your house to the Carter Hayes of Pacific Heights and just like the movie didn't collect a securities deposit to cover the damages from trashing the place.

In addition to paying rent to just live there...when a housing tenant exits there is an exit inspection looking for damages and when found they are subtracted from the security deposit and if the damages exceed the "2 months" deposit then the landlord requests more funds and if they don't get them they can sue for the extra damages.

So what should we consider "damages" in the context of Securities Lending???

How do you demonstrate "harm" in this case? Economics 101 says increasing supply holding demand constant will force prices lower... but how much lower?

How can a fund manager decide if the few basis points he collects for securities lending offsets the impact of increasing the supply of stock and causing prices to go down? 

The problem is this is typically seen incrementally..." well whats the big deal if I loan out a few shares... how can that effect the stock price significantly" rather than in aggregate... "what if we all lend out our stock how much could that push prices down?"

I would suggest that the "stack" analysis demonstrates devastation to the stock price.

But what if the tenant of the stock does more than just sell it what if they actively participate in lowering the demand for the house. Imagine if you will renting to a person who spends all his time trash talking the house to his new neighbors.

take for example a well timed negative "investigative journalist" or CNBC appearance piece using Pacific Heights tactics of Fear, Uncertainty, and Distortion to lower demand as the same time you increased the supply of stock... double trouble.

Securities lenders do not appreciate the risks by lending their stock to those motivated to do ANYTHING to lower the price of the assets being lent out.

The paltry fee collected can't possibly offset the hazard of renting out the stock to a " Carter Hayes" or as some would like to call it in the stock world a "Sith Lord". These Sith lords will borrow your stock and eat it for lunch after they are done trashing it for days, weeks, or months there may be little left of your "house" for you to recover after they've moved out.

I don't care if the house was of poor construction it doesn't  "deserve" an early demise thanks to Mr. Hayes... it isn't right for your fund(pension, insurance, mutual fund) etc to be collecting trivial fees in exchange for handing your stock over to the bandits to destroy. Please do share with me how there can remotely be a benefit to loaning your house to someone with a vested interest in destroying its value.

Keep in mind without securities lending or the "margin agreement" someone who wanted to bet against a company is limited to an option market (if it exists) and can't directly impact supply of the stock by buying a put. Essentially short sellers are not only betting its going to rain but seeding the clouds by selling the stock and trashing it with FUD.